Wednesday, April 22, 2015

Fess up

Tim Massad, the head of the Commodity Futures Trading Commission, which oversees the trading of futures and swaps, said on Wednesday that it took so long to charge Sarao because of the size and complexity of U.S. derivatives markets. "These are huge markets," he said. "There's a lot going on."

The faster your trading system, the quicker you can take advantage of those discrepancies. But that is not all the high-frequency traders can do. They can “front-run” news events, jumping on anything that might move a price, and get in and out of a stock before anyone else knows that something has happened. By trading at such speed, they can even get into an equity in the gap between the placing of a large buy order and the execution of it, and thereby buy just before the price rises.

Sherrod Brown, the top Democrat on the Senate banking committee, told the Financial Times: “It’s encouraging that the Justice Department and [Commodity Futures Trading Commission] are pursuing this case, but troubling that it has only come to light now with the help of a whistleblower who invested substantial time in putting the pieces together.”

Adding to concerns, the CFTC was alerted to Sarao's alleged misdeeds by a whistle-blower, who has not been identified, according to Shayne Stevenson, who represents the whistle-blower through Hagens Berman law firm in Seattle. Stevenson said his client brought "high-quality information" about "market manipulation" to the CFTC, which alerted the DOJ.

A British man accused of market manipulation that contributed to the May 2010 Wall Street "flash crash" said he opposed being extradited to the United States, while the operator of the market where he traded sought to rebut prosecutors' suggestion that futures helped cause the crash.

More than a year before the May 6, 2010 "flash crash," CME Group noticed questionable trading in its E-mini market by a particular electronic trader who was placing orders and cancelling them.

As the crash whipsawed the futures and stock markets in 2010, CME saw the suspicious activity again and warned the trader that day that orders must be placed “in good faith,” without an intent to cancel. The trader responded two weeks later: “Kiss my ass.”

He seems to have executed his trades out of a modest, semi-detached house under the Heathrow flight path that he shared with his parents. He used off-the-shelf software that he souped up to make his bets. He named one shell company "Nav Sarao Milking Markets Ltd." The guy showed up to court in a pair of white sweatpants.

But surely, since then regulators went through the action that took place on and around the day of the Flash Crash with a very fine comb? And if so, why did Sarao's alleged actions not jump at them as strange at the time?

The CME Group declined to comment, citing the ongoing investigation. But analysts worry that the CME’s revenue model interferes with its motivation to police trading. The more trades that zip through the exchange, the more money it makes. That means it could be disincentivized from tackling manipulative traders who still bring valuable liquidity to the market.

Junk Debt collapsed a full hour before the stock market Flash Crash took place (and I would add that utilities and Treasurys were leading prior, indicating a VIX spike was possible). If junk debt collapses, how can stocks not collapse afterward when in a bankruptcy proceeding, junk debt has a higher claim on assets than equity? What caused the Flash Crash in stocks was a Flash Crash in junk debt, which was like a 1987 style crash in credit.